DP16639 The Unemployment-Risk Channel in Business-Cycle Fluctuations
We quantify the unemployment-risk channel in business-cycle fluctuations, whereby an initial contractionary shock is amplified through workers reducing their demand in fear of unemployment. We document two stylized facts on how unemployment and unemployment risk respond to identified demand and supply shocks in US data. First, separation and job-finding rates play similar important roles in accounting for the overall unemployment response. Second, separations are more important early on, while job-finding rates respond with a lag. We show how a tractable heterogeneous-agent new-Keynesian model with a frictional labor market matches both facts once we include endogenous separations and sluggish vacancy creation. Relative to a model with exogenous separations and free entry, our framework attributes almost twice as large a share of output fluctuations to the inefficient unemployment-risk channel, and thus gives a larger role to stabilization policy.